Structure and content of a Lease (part two)

A covenant by the tenant to pay for the insurance policy

Often there can be a covenant for a tenant to pay a sum received as rent which includes the premium for the buildings insurance policy and associated policy covering the landlord for the loss of the annual rent during any period where the tenant is unable to use the building following the occurrence of an insured risk.

A covenant by the landlord to reinstate the property

Often this is expressed as a covenant to use the insurance proceeds to reinstate the property rather than absolute obligation to reinstate even if the proceeds are insufficient. Ideally a tenant would like to extend this to include an obligation to the landlord to make good any shortfall in the insurance proceeds from its own resources as there will have been a failure to insure the property to its full reinstatement value.

Road suspension

In the absence of an expressed term to the contrary rent will continue to be payable even if the property is rendered unusable. The tenant should therefore ensure that the Lease provides for the payment of rent to be suspended during any period that the property cannot be occupied following damage by an insured risk.

Termination

Unless the Lease states otherwise if the building is totally destroyed the doctrine and frustration will only apply in exceptional circumstances therefore the Lease will often give the landlord the right to terminate the Lease should reinstatement prove impossible. The tenant should try to ensure that they have the same right particularly when the rent suspension is time limited. The tenant should be able to terminate the Lease if the property has not been reinstated by the end of the rent suspension period otherwise they would be paying rent for a property which they cannot use as well as on alternative premises.

Alterations

Often tenants would like to be able to make alterations to a property. Obviously landlords would like to be able to control the nature of those alterations so as they do not lose control over their freehold property. There are a number of different kinds of covenant that could be used in order to achieve a balance.

Absolute covenants – A landlord may impose an absolute covenant against all types of alterations but it’s more common for a Lease to contain this type of covenant in relation to structural and exterior alterations. A tenant can use provisions of s.3 of the Landlord and Tenant Act 1927 to enable it to carry out improvements even where the Lease contains an absolute prohibition. Under s.3 a tenant who wants to carry out improvements can serve a notice on the landlord detailing its proposals. The landlord has three months within which to object and if it does the tenant has the right to apply to the court for authorisation to carry out the improvements.

Qualified of fully qualified covenants – Many landlords will allow tenants to make non-structural alterations and changes to service media but with consent so that the landlord can retain control by imposing conditions about how the works are done and whether they will need to be removed and the property reinstated at the end of the term. The consent and the conditions will typically be imposed in a separate document called a Licence to Alter. A tenant who has obtained prior authorisation to make improvements by using the s.3 statutory procedure is entitled to claim compensation for improvements at the end of the term that ‘Add to the letting value of the holding under s.1 of the 1927 Landlord and Tenant Act provided the claim is made within certain statutory time limits’.

There could be reasons why a landlord wants to restrict the use of their property. For a retail premises this could require a covenant to keep a balance of shops within a shopping centre to keep the nature of a centre in keeping with other shops etc a landlord may therefore choose to impose a tenant’s covenant which restricts the use of the property to a single purpose.

However a narrower clause might put off a tenant who wants to retain the possibility of diversifying the business or disposing of the Lease at a later stage so it could say something like not to use the premises for any other restaurant other than a restaurant or such other use falling within use class E of the Town and Country Planning Act. Unlike alienation covenants there is no statutory implication of the landlord’s consent to not be unreasonably withheld for user covenants but the landlord cannot charge a fine or an increased rent as a condition of giving consent provided no structural alteration is involved this is in accordance with s.19(3) of the Landlord and Tenant Act of 1927.

Alienation

Alienation is a generic term which includes different ways of creating an interest in the property for the benefit of a third party. The landlord will have chosen the original tenant of the Lease carefully based on the tenant’s strength of covenant i.e. the tenant’s ability to pay the rent and perform the covenants in the Lease. In the absence of a restriction in the Lease a tenant can dispose of their interest in any way they like.

The landlord will want control over whoever else might occupy the investment property and will usually insist upon restrictions in the Lease against tenants dealing with the leasehold interest. Alienation can include assignment or underletting, charging (also known as mortgaging) or sharing occupation by allowing a third party in while continuing to occupy. Most Leases will contain an absolute covenant against all kinds of alienation but then go on to permit certain kinds of alienation and controlled terms. Where a Lease is granted it is possible to transfer the Lease to someone else otherwise known as assignment or allow someone else to occupy the building on what is known as an Underlease or Sub-Lease the two terms are interchangeable after the original tenant there may also be different people who have owned the Lease and occupied the premises.

A commercial Lease will usually allow assignment of the whole property but not of part as many properties are unsuitable for legal and physical sub-division into separate ownership. There are three strategy provisions that are relevant to assignment covenants: s.19(1)(a) of the Landlord and Tenant Act which reads as follows.

1) In all leases whether made before or after the commencement of this Act containing a covenant condition or agreement against assigning, underletting, charging or parting with the possession of demised premises or any part thereof without licence or consent, such covenant condition or agreement shall, notwithstanding any express provision to the contrary, be deemed to be subject—

(a) to a proviso to the effect that such licence or consent is not to be unreasonably withheld, but this proviso does not preclude the right of the landlord to require payment of a reasonable sum in respect of any legal or other expenses incurred in connection with such licence or consent;

s.19(1)(A) of the Landlord and Tenant Act 1927 which reads as follows

Where the landlord and the tenant under a qualifying lease have entered into an agreement specifying for the purposes of this subsection—

(a) any circumstances in which the landlord may withhold his licence or consent to an assignment of the demised premises or any part of them, or

(b) any conditions subject to which any such licence or consent may be granted,

then the landlord—

(i) shall not be regarded as unreasonably withholding his licence or consent to any such assignment if he withholds it on the ground (and it is the case) that any such circumstances exist, and

(ii) if he gives any such licence or consent subject to any such conditions, shall not be regarded as giving it subject to unreasonable conditions.

And s.1 of the Landlord and Tenant Act of 1988, which states:

(1) This section applies in any case where—

(a) a tenancy includes a covenant on the part of the tenant not to enter into one or more of the following transactions, that is—

(i) assigning,

(ii) underletting,

(iii) charging, or

(iv) parting with the possession of,

the premises comprised in the tenancy or any part of the premises without the consent of the landlord or some other person, but

(b) the covenant is subject to the qualification that the consent is not to be unreasonably withheld (whether or not it is also subject to any other qualification

You may be required to know and be able to use these statutory authorities in the SQE1 assessments.

Procedural steps for the grant of a lease or underlease

The process of granting a lease or underlease is procedurally very similar to that used for a freehold transaction. Where a commercial lease is for a comparatively short term a prospective tenant may choose not to carry out some of the more usual steps such as investigating title. However, we will proceed on the basis that the client wishes all of these steps to be carried out.

One of the major considerations for a landlord will be the reliability of a potential tenant. The landlord will accept the tenant based on what is known as the tenant restrictive covenant ie the ability of the tenant to pay the rent and perform the covenants. The following are the key steps you might consider.

Drafting the lease

The landlord’s solicitor will usually be responsible for drafting a lease which will then be sent to the prospective tenant’s solicitors. They will check it, probably amend it and send it back. It will go back and forth until it is finally agreed.

Once the solicitors have agreed the form of the lease and carried out all the pre-contract steps they should be ready to complete on the grant of lease. A contract usually called an agreement for lease will be used for where there is going to be a delay between agreeing the lease and underlease and actually granting it but one or both of the parties requires the other to be bound by the transaction this could include situations where the landlord is in the process of constructing the property and wants to know that the tenant is bound to take the lease on completion. Or where the landlord is carrying out works of repair or refurbishment at the request of the tenant in which case the landlord may not be able to secure funding for the works unless there is a legal enforceable commitment from the tenant.

Where an agreement for lease is required it is drafted by the landlord’s solicitor in the same way that the seller’s solicitor drafts the contract in the case of the sale of a freehold property. The particulars of sale must state the property is leasehold and give details of the term to be vested in the tenant. Encumbrances affecting the superior title must be disclosed and the agreement should provide for an indemnity to be given in the lease or underlease in respect of future breaches of any covenants affecting the title.

Deduction of title

Before drafting the lease or underlease the landlord’s solicitor will need to investigate the client’s title to ensure that the client is entitled to grant it. Where the property is subject to an existing mortgage the mortgage will frequently contain a prohibition or restriction on the borrower or landlord’s ability to grant the lease on that property so the lender must be contacted, and its permission obtained before the transaction proceeds. Investigation of title is done in exactly the same way as if the solicitor was acting for a freehold transaction.

Pre-completion formalities

The lease or underlease is normally prepared in two identical parts the lease and counterpart. The lease is executed by the landlord and the counterpart by the tenant. On completion these are exchanged so that each party as a copy of the lease signed by the other in case of a subsequent dispute. As with the transfer deed in the case of the sale of freehold land a top copy or engrossment of the lease or underlease and counterpart will need to be made and it is these that the parties will sign. The landlord will sign the lease itself in readiness for completion and the counterpart should be sent to the tenant’s solicitor for execution by the tenant.

Completion and post completion steps

On completion and in addition to matters relevant to a freehold transaction the landlord will receive (a) the counterpart lease or underlease executed by the tenant (b) any premium payable for the grant (c) an apportioned sum representing rent payable in advance of the lease or underlease and the landlord should give the tenant firstly the lease or underlease executed by the landlord. Secondly if not already done properly marked or certified copies of the freehold title deeds and thirdly where relevant a certified copy of the consent of the landlord’s lender to the transaction.

SDLT and LTT

A land transaction return must be submitted to HMRC on the grant of a lease in the usual way. In the case of a grant of a lease SDLT is potentially chargeable both on any capital sum being paid and on the amount of the rent.

A legal lease for seven years or less is not capable of being registered with its own title at the Land Registry. In registered land such a lease will take effect as an overriding interest under the Land Registration Act 2002 whether or not the tenant is in actual occupation of the land. It is possible to note leases of over three years against the landlord’s title voluntarily. In unregistered land a legal lease is binding on all subsequent owners of the land irrespective of notice.

The grant of a lease for a term which exceeds seven years is registerable in its own right after completion irrespective of whether the freehold title is registered. It will be registered with its own separate title and title number and if the landlord’s title is registered it will also be noted against the freehold title.

If the freehold is unregistered the tenant’s application to the Land Registry is for first registration and the application must be made within two months of completion of the grant of the lease.

If the freehold is registered the tenant’s application for registration of a dealing with the freehold title and the application must be made within the priority period.